Thursday, 28 October 2010

How will the Yen react to the imminent BOJ policy decision? While all eyes are on the Nov. 3rd Fed meeting, the Japanese central bank may be set to initiate a significant quantitative easing program of its own.

Forex traders are waiting intently for the release of the Bank of Japan’s latest policy decision, which will be released sometime during Thursday, likely in the next few hours.

Recall that at the last meeting on October 5th, the central bank surprised markets by cutting its benchmark overnight rate to between 0.00% and 0.1%, down from 0.1% where the rate held since December 2008. The Yen fell sharply immediately after the move, but then proceeded to advance once again. Just two days ago we saw the Japanese currency at a new 15-year high versus the U.S. Dollar. Thus if the BOJ’s goal is to weaken the country’s currency, it has so far failed in that regard.

But the reality is that the Yen is only one consideration of the BOJ. More important is the overall health of the Japanese economy. And while the strength in the Yen has been a negative drag on the economy through its impact on the export sector, the movement we see in the Yen may only be a symptom of a bigger problem facing Japan, namely deflation. In fact, all else equal, deflation leads to an increase in the purchasing power of a currency as prices of goods and services fall, which translates into a strong currency.

If the BOJ can successfully address the deflation monster, the performance of the economy will improve and the Yen may become less of a burden naturally.

In the next few hours we will find out exactly what steps the central bank will take in its battle against deflation. At the last meeting, the BOJ made clear its intention to establish an asset purchase program. The details of this program are what traders will be closely watching for.

In many ways this program the BOJ is setting up is a form of quantitative easing. In fact this program may turn out to be quite similar to that the U.S. Federal Reserve is expected to announce on November 3rd. But while the Fed will most likely buy government bonds exclusively, the BOJ may additionally purchase corporate bonds, exchange-traded funds, and even Japan real estate investment trusts. In terms of the size of the program, the central bank indicated a $5 trillion Yen figure, or close to $60 billion USD. To put that in perspective, many market sources are speculating that the Fed will announce a quantitative easing (QE) program of a few hundred billion dollars.

The Yen’s reaction to the BOJ’s new QE program will largely be a function of size and the central bank’s associated comments. If the program is larger-than-expected or there is room to increase the program’s size in the future, that could put pressure on the Yen.